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thinking about writing some spreads
Old 01-15-2011, 01:47 PM   #1
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thinking about writing some spreads

I have 50 contracts of MSFT $27.50 Jan 12 calls purchased at $2.90 that I am thinking about turning into what is called a bull call spread by writing some Jan 12 calls at $30 for 1.80. On paper, it looks pretty decent, if I have things calculated correctly:

Total purchase price: $14,500
Cash from writing $30 calls: $9,000

Total at risk: $4500 (plus commisions)

I break even if the stock closes 2011 at $28.50ish and I make $7000 if the stock closes above $30 (pretty likely). The most I lose is $4500.

Seems reasonable for my high risk/high reward play money account in my IRA. That would be a 48% return for a max loss risk of 31% if I calculated things correctly. I think this might be quite a bit less risky than just holding the Jan 12 $27.50 calls as I orginally intended, where my max profit is unlimited, but my max loss is also 100%.

Any of you write spreads? I have to upgrade my Etrade account from level 2 to level 3 to even be able to do this...even though as I pointed out, the spread seems to have less risk than buying a call (which you can do in level 2).
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Old 01-15-2011, 05:17 PM   #2
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Originally Posted by 79protons View Post
Any of you write spreads? I have to upgrade my Etrade account from level 2 to level 3 to even be able to do this...even though as I pointed out, the spread seems to have less risk than buying a call (which you can do in level 2).
Without commenting on the merit of your strategy, I would just like to point out that you are purchasing a spread, not writing one, as you are paying a net premium as opposed to receiving a credit.

And, of course, it's less risky than holding a naked long call since you have capped your upside.
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Old 01-15-2011, 05:22 PM   #3
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I write a fair amount of options, primarily covered calls, and a few naked puts. Along with a rare spread, naked called etc. In the past I have tended to write primarily long-term contracts 6+ month.

However, I have become increasingly cautious about doing so for two reasons. First the VIX dropped to 15.46 yesterday. You have to go back to 2007 to find the VIX at such low levels. It seems to me that apparent risks to the stock market are much greater now than they were in 2007. (We didn't know what didn't know back then.) Thus the premium for writing options is pretty modest.

Second after reading the Big Short, I was struck by the finding of couple of unlikely hedge fund manager. These two guys (Cromwell Capital Management) did an evaluation of long term options and found they black-scholls model significantly undervalued the risk associated with writing them. They were making modest amounts of money, until they stumbled upon long term options for various CDS and MBS which eventually turned their 100K into 100 Million.

So in a nutshell I don't find the risk/reward for writing long-term options to be especially appealing in this market.

I don't have any thoughts about the particular spread, but in general if this is your gambling play account, then gamble.
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Old 01-15-2011, 05:28 PM   #4
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Without commenting on the merit of your strategy, I would just like to point out that you are purchasing a spread, not writing one, as you are paying a net premium as opposed to receiving a credit.

And, of course, it's less risky than holding a naked long call since you have capped your upside.
Yes, thanks for correcting me on that...I really only have experience right now with calls, puts and writing covered calls.

I think I may modify my strategy a bit and try to time the market before selling the $30 call. Microsoft will typically make a few % run up before earnings (on the 28th) and perhaps if I get a bit lucky I can manage to get close to what I paid for the $27.50 call for the $30 call I write. I could see this happening at $30.25 or so...not sure if it would hit that before earnings....but that is what makes having a little play money account so much fun.
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Old 01-15-2011, 05:36 PM   #5
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I think I may modify my strategy a bit and try to time the market before selling the $30 call. Microsoft will typically make a few % run up before earnings (on the 28th) and perhaps if I get a bit lucky I can manage to get close to what I paid for the $27.50 call for the $30 call I write. I could see this happening at $30.25 or so...not sure if it would hit that before earnings....but that is what makes having a little play money account so much fun.
Alternatively, if you think there will be a run up prior to the earnings announcement, why not try to capture it with shorter term options, e.g. the February's. You will pay a lot less net premium to set up the bull spread.
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Old 01-15-2011, 07:41 PM   #6
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Originally Posted by 79protons View Post
I have 50 contracts of MSFT $27.50 Jan 12 calls purchased at $2.90 that I am thinking about turning into what is called a bull call spread by writing some Jan 12 calls at $30 for 1.80. On paper, it looks pretty decent, if I have things calculated correctly:

Total purchase price: $14,500
Cash from writing $30 calls: $9,000

Total at risk: $4500 (plus commisions)

I break even if the stock closes 2011 at $28.50ish and I make $7000 if the stock closes above $30 (pretty likely). The most I lose is $4500.

Seems reasonable for my high risk/high reward play money account in my IRA. That would be a 48% return for a max loss risk of 31% if I calculated things correctly. I think this might be quite a bit less risky than just holding the Jan 12 $27.50 calls as I orginally intended, where my max profit is unlimited, but my max loss is also 100%.

Any of you write spreads? I have to upgrade my Etrade account from level 2 to level 3 to even be able to do this...even though as I pointed out, the spread seems to have less risk than buying a call (which you can do in level 2).
Good advice from the other posters. I'll just add:

Yes, it seems like you did not calculate things correctly - you have a $5,500 potential loss, $14,500-9,000 (plus comm/fee), not $4,500. But that's not a major factor.

MSFT is now ~ $28.30. What makes closing above $30 a year from now 'pretty likely'? A year ago, MSFT was ~ $31. Would you have said it was 'pretty likely' to close above ~ $32.75 this month? You would have been wrong.

Further, if closing above $30 is 'pretty likely', why the heck are people on the other side of this trade offering premiums to allow you to make a profit on what is 'pretty likely'? Are they stupid, or just good Samaritans that would like to give you some easy money?

You may or may not make a profit, but that can be said of anyone buying a lottery ticket.

edit/add - you essentially have $1.10 per share at risk with the spread. You could also do this by purchasing a $32.50 JAN2012 call. Again, if you think that is 'more risky' than what you propose with the spread, you have to ask yourself - why are people offering those prices on those products?

You might want to search for "insane" in the subject heading for an account of someone who thought he was getting a better deal than the other guy.

I'll save you the trouble, here it is (SPOILER ALERT: It ends badly): Insane Emergency RE strategy

-ERD50
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Old 01-15-2011, 08:07 PM   #7
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Good advice from the other posters. I'll just add:

Yes, it seems like you did not calculate things correctly - you have a $5,500 potential loss, $14,500-9,000 (plus comm/fee), not $4,500. But that's not a major factor.

MSFT is now ~ $28.30. What makes closing above $30 a year from now 'pretty likely'? A year ago, MSFT was ~ $31. Would you have said it was 'pretty likely' to close above ~ $32.75 this month? You would have been wrong.

Further, if closing above $30 is 'pretty likely', why the heck are people on the other side of this trade offering premiums to allow you to make a profit on what is 'pretty likely'? Are they stupid, or just good Samaritans that would like to give you some easy money?

You may or may not make a profit, but that can be said of anyone buying a lottery ticket.

edit/add - you essentially have $1.10 per share at risk with the spread. You could also do this by purchasing a $32.50 JAN2012 call. Again, if you think that is 'more risky' than what you propose with the spread, you have to ask yourself - why are people offering those prices on those products?

You might want to search for "insane" in the subject heading for an account of someone who thought he was getting a better deal than the other guy.

I'll save you the trouble, here it is (SPOILER ALERT: It ends badly): Insane Emergency RE strategy

-ERD50

The PE has been compressing for the past 10 years and I do not believe the tablet market is going to kill of PCs at anywhere near the rate everyone else does. Thus to me, it is pretty likely that MSFT will be near $30 next Jan after having a year of strong earnings. People are discounting microsoft because they have made poor assumptions about where technology is going, imo.
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Old 01-15-2011, 08:19 PM   #8
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The PE has been compressing for the past 10 years and I do not believe the tablet market is going to kill of PCs at anywhere near the rate everyone else does. Thus to me, it is pretty likely that MSFT will be near $30 next Jan after having a year of strong earnings. People are discounting microsoft because they have made poor assumptions about where technology is going, imo.
Well, you might be right, but just be aware that you are, in effect, saying that you are smarter than the other people putting their money where their mouth is.

FYI, I made a ton of money in AAPL back in the late 90's. 'Everyone' thought Apple would be bankrupt, and I though different. I was right, but I could have been wrong (or I could not have held out long enough for the market to recognize the value in AAPL). So it can be done, but I wouldn't take anything for granted, or describe it as 'pretty likely'.

I also stopped trading AAPL @ ~ $100, and now it's $348! What the heck do I know!

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Old 01-15-2011, 08:39 PM   #9
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Wow, I skimmed through that thread and yes, it is pretty revealing on how a few successful trades can make one overconfident. The sad thing is, the guy would have been able to retire if he had just kept his APPL LEAPS back in 2009 instead of trying to do the spreads to get 3% return per month.

I have had some good luck also, and am very overconfident in my ability to pick potential winning stocks. I know this is going to bite me in the butt soon so I keep all of my trades in one little IRA I started a few years back with $1700. It is now a little over $60,000 but I haven't made any contributions to it. I have put $40,000 into a Vanguard fund to keep it out of my reach and I play around with the other $20K. Our main portfolio is all in Vanguard stock and bond funds (and some cash).

Interesting that you pointed out a lot of stuff to that guy but he ignored it. I am letting you know I am not ignoring you (and others). As soon as I lose the 20K, I am done. My hope is to have a bit more fun with it until then by picking the best plays I can. Right now those are MSFT and CSCO. I would short AAPL but too many fanatics means I would lose that bet. Anyway, it won't mean a thing if I lose the 20K or turn it into 40K..it is all a lottery, just with a bit better odds than the one the state gives you on the scratch and win cards.
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Old 01-15-2011, 10:07 PM   #10
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My hope is to have a bit more fun with it until then by picking the best plays I can.
You may be fine, I don't pay much attention to this kind of speculation so I have no expertise. Two observations though. 1) Even if it works, it is not a big hit. This is something that you must do over and over to make significant money. And 2) If you are looking for fun, there are many places to have more fun with less potential cost than financial markets.

Ha
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Old 01-15-2011, 10:25 PM   #11
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You may be fine, I don't pay much attention to this kind of speculation so I have no expertise. Two observations though. 1) Even if it works, it is not a big hit. This is something that you must do over and over to make significant money. And 2) If you are looking for fun, there are many places to have more fun with less potential cost than financial markets.

Ha
Hmmm, not sure. It is pretty fun for me to monitor the stocks and read the reports, make semi educated guesses about future trends. I treat it like a game. I still consider $5 to be significant money even on a day where my portfolio goes up $5000.

I am sure I will get bored with this after awhile and just park the money in some index fund. I have learned a lot in the past year about finances, which is a good consequence of this.
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Old 01-15-2011, 10:49 PM   #12
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Hmmm, not sure. It is pretty fun for me to monitor the stocks and read the reports, make semi educated guesses about future trends. I treat it like a game. I still consider $5 to be significant money even on a day where my portfolio goes up $5000.
I know that you said you already view your $20k as a "lottery plaything" portfolio, since you already have sequestered $40k into safer investments...and I realize that you could turn that $20k into a much larger sum.

But the way I would look at it, since you've already won a "small lottery jackpot", why not put all $65k in your retirement accounts into conservative investments, and play with $20k in a taxable account? that way, if the long-run average catches up to you sooner rather than later and you lose the $20k, you can at least write it off your taxes.

If you do well with this $20k, what is the next plan? Grow it to $40k, move $20k off the table into the conservative investments, and keep playing with $20k? Any goal of when you'll cash-out completely and not take long positions in options in your tax-advantage accounts?
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Old 01-15-2011, 11:00 PM   #13
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If you do well with this $20k, what is the next plan? Grow it to $40k, move $20k off the table into the conservative investments, and keep playing with $20k? Any goal of when you'll cash-out completely and not take long positions in options in your tax-advantage accounts?
Heh, yeah, that was my general plan. If I doubled the 20K, move half to the conservative investments and reset back to 20K again.

Maybe I could still have fun if I scaled back even more. 20K seemed reasonable to be able to have a few different trades going without having 25% of the return eaten up by trading commissions.

The reason I didn't want to do this in a taxable account is I did not want to deal with tax record keeping, or worry about wash sales when I did this or that trade. Last year I had about 135 trades just in this one account.

My goal is to quit whenever I lose 20K or hit 100K total in my IRA.
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Old 01-17-2011, 07:42 PM   #14
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I would short AAPL but too many fanatics means I would lose that bet.
Hmmm, maybe I should have bought some AAPL puts after all...

Feel bad for Steve, but this is going to bring down the whole tech sector tommorow. Not great for my MSFT and CSCO plays...
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Old 01-20-2011, 04:05 PM   #15
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I'll save you the trouble, here it is (SPOILER ALERT: It ends badly): Insane Emergency RE strategy

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Thanks for that link. I always wondered what happened to the guy who's retirement plan envisioned generating 80% annual returns trading options.
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Old 01-20-2011, 10:20 PM   #16
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I always wondered what happened to the guy who's retirement plan envisioned generating 80% annual returns trading options.
Pretty much the same way all those types of plans turned out...
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